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Asset class diversification and delegation of responsibilities between central banks and sovereign wealth funds

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  • Joshua Aizenman
  • Reuven Glick

Abstract

This paper presents a model comparing the optimal degree of asset class diversification abroad by a central bank and a sovereign wealth fund. We show that if the central bank manages its foreign asset holdings in order to meet balance of payments needs, particularly in reducing the probability of sudden stops in foreign capital inflows, it will place a high weight on holding safer foreign assets. In contrast, if the sovereign wealth fund, acting on behalf of the Treasury, maximizes the expected utility of a representative domestic agent, it will opt for relatively greater holding of more risky foreign assets. We also show how the diversification differences between the strategies of the bank and SWF is affected by the government’s delegation of responsibilities and by various parameters of the economy, such as the volatility of equity returns and the total amount of public foreign assets available for management.

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Bibliographic Info

Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2010-20.

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Date of creation: 2010
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Handle: RePEc:fip:fedfwp:2010-20

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Keywords: Banks and banking; Central ; Sovereign wealth fund;

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  1. Joshua Aizenman & Reuven Glick, 2008. "Sovereign Wealth Funds: Stylized Facts about their Determinants and Governance," NBER Working Papers 14562, National Bureau of Economic Research, Inc.
  2. Joshua Aizenman & Reuven Glick, 2005. "Pegged exchange rate regimes -- a trap?," Working Paper Series 2006-07, Federal Reserve Bank of San Francisco.
  3. Aizenman, Joshua & Marion, Nancy P., 2003. "International Reserve Holdings with Sovereign Risk and Costly Tax Collection," Santa Cruz Department of Economics, Working Paper Series qt9s7978n1, Department of Economics, UC Santa Cruz.
  4. Olivier Jeanne, 2007. "International Reserves in Emerging Market Countries: Too Much of a Good Thing?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 38(1), pages 1-80.
  5. Maurice Obstfeld, 1995. "Models of Currency Crises with Self-Fulfilling Features," NBER Working Papers 5285, National Bureau of Economic Research, Inc.
  6. Edwin M. Truman, 2008. "A Blueprint for Sovereign Wealth Fund Best Practices," Policy Briefs PB08-3, Peterson Institute for International Economics.
  7. Joshua Aizenman & Reuven Glick, 2007. "Sovereign wealth funds: stumbling blocks or stepping stones to financial globalization?," FRBSF Economic Letter, Federal Reserve Bank of San Francisco, issue dec14.
  8. Aizenman, Joshua & LEE, JAEWOO, 2005. "International Reserves: Precautionary versus Mercantilist Views, Theory and Evidence," Santa Cruz Department of Economics, Working Paper Series qt2tn4w8x6, Department of Economics, UC Santa Cruz.
  9. Walsh, Carl E, 1995. "Optimal Contracts for Central Bankers," American Economic Review, American Economic Association, vol. 85(1), pages 150-67, March.
  10. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
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